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Extra Shares - to buy or njot to buy?

Extra Shares – to buy or not to buy?

Many of you will have been given the opportunity to buy extra shares in your banks recently as they attempt to raise extra cash. Should you take them up on their offers? Moneyagonyaunt finance expert John Eaton of Lupton Fawcett in Leeds has (what he calls) a typical solicitor’s answer!

When companies need to raise more money, but don't necessarily want to borrow more, they often do declare a "Rights Issue"; This is simply an offer of further shares to the existing shareholders in proportion to their existing shareholdings, and (usually) on favourable terms - e.g. the right for them to acquire one further share for, say, every three they already hold, and at a discounted price - i.e. one which is below the current market price. From the Company's point of view, this is a cheap and convenient way of raising further funds. From the shareholder's point of view, this could be an attractive "top up" investment opportunity.

So, should you take up the rights which are provisionally allotted to you? Generally speaking, the answer will usually be "yes" - for three reasons: 1. Rights Issues represent a very cheap (nil cost - you can't get cheaper than that!) way of acquiring more shares in a Company in which you are already a shareholder 2. A rights issue usually offers an immediate capital profit, since the Offer price is usually much lower than the current market value - i.e. the shares are available at a discount3. Taking up the shares avoids "diluting" your stake in the Company - if you hold say 1% of the Company, but did not take up the rights, your percentage holding would then fall below 1%. By taking up the rights, you preserve your shareholding at 1% of the Company. (In practice, this doesn't really have any significance, as a private shareholder's stake will usually be too small for this to make any difference anyway).

However, those three reasons should all be looked at in the light of the one fundamental question - if you had cash, but no shares in the Company, would you now go out and buy shares in this Company, in the light of its future prospects? If you wouldn't buy the shares today, then (a) why are you still holding them at all?! and (b) why would you want to buy more shares in a Company which you don't regard as "a buy"?! ( An obvious but painfully necessary question!). A clue can be found in answering the question "Why is the Company having a Rights issue in the first place?" If it is for a good commercial reason - to expand, to take over another Company, to buy a new business or develop a Patent, or invest in new technology, or even to reduce a particular debt - then, fine - it is probably worth supporting. But if the rationale is simply to bolster the Company's Balance Sheet, and if the Company's future prospects are not that impressive, then why risk "throwing good money after bad"?

For example, in the Banking Sector (where there have been a few Rights issues recently), the "downside" is pretty obvious - in particular, the unquantifiable cost of all those unserviceable loans and toxic debts - and therefore the risk that the Company will need more "rescue cash" - or will end up being nationalised entirely, at some future stage. If you're cautious, or pessimistic about the future, then I would leave the Company to sell the rights, and pick up the premium which they would obtain for you. Logically, you would also sell your other shares in the Bank, at the same time.

However, if you're happy to take a punt on the future of the Company (which is what you would be doing) then take up the rights - especially if the amount at stake is one which you could afford to lose, if everything went pear-shaped - and simply keep your fingers crossed, that things work out well for the Bank - which they might or might not do!